My Email Reply To A Suspicious Hedge Fund

I thought I found a fraudulent hedge fund earlier today. I will refrain from judgement as there are lots of details arguing for reckless ineptitude versus fraud. However, I will share my response to the fund’s marketing email as a public service since it sheds some light on basic due diligence checks investors should think about when considering investment opportunities.

Since I do not have proof of any wrongdoing I have redacted all identifying information. If this turns out to be a scam I will do a follow-up post with additional details.

Dear (Redacted) –

I took a pass through your marketing material and would like to share some feedback you may find useful as you approach other sources of institutional capital:

1)      Your hedge fund does not use an independent administrator (noted on your ADV and also omitted from your “Third Party Support Services” page). I have conducted due diligence on a number of hedge funds ranging in size from several million dollars to several billion in AUM and yours is the first that has not used an independent administrator. Most of us responsible for conducting due diligence would consider this a major red flag as the administrator serves an important control function where portfolio valuations and trading activity are concerned.

2)      You are the first dedicated distressed investor I have seen with so many outside business activities (firm website lists 7 outside business activities for the CEO). With so many demands on your time, it is difficult to believe you have the time and energy to do the deep credit and risk management work on a distressed debt portfolio.

3)      I find your firm’s web presence a bit concerning, to say the least. (Website redacted) does not shine a positive light on your firm. To be frank, it gives one the impression that you are appealing to unsophisticated retail investors focused on yield. This is not a good look for a hedge fund marketing to institutional investors. In fact, I usually consider this type of marketing a flag for fraud. Furthermore, I find the (website redacted) reference to your track record in the early 2000s a bit misleading. To highlight the performance of a tech-heavy equity portfolio at the peak of the dot-com bubble with no reference to performance beyond that makes that performance data seem questionable at best.

4)      For a hedge fund, your team seems to have remarkably little experience in the distressed arena. Based on your website, your Ops Manager does not appear to have any prior experience in operating a hedge fund or mutual fund. In fact, your Ops Manager seems to not have any financial sector experience at all. In addition, your Fixed Income Consultant and Research Analyst appear to have little specialized background in distressed investing (both seem more suited to serving retail advisory clients).

To be honest, when I initially reviewed your material I felt you might be perpetrating a financial fraud scheme. The fact you did not show regulatory disclosures on BrokerCheck or IAPD reassures me somewhat on that front.

However, as an analyst who performs due diligence on investment managers for a living I remain concerned you are going to lose unsuspecting retail clients a significant amount of money. If you are truly interested in acting in your clients’ best interest, I would encourage you to think carefully about the risks you are taking with your investors’ capital, and to work toward professionalizing your marketing materials and operational infrastructure.

Something I did not tell the fund in my email but I did do on my own initiative was call the auditor listed in the marketing material. The marketing material presented so strangely that I felt there was a non-zero probability the firm lied about having an auditor in the first place. If this were the case I would have forwarded the information and my suspicions to the SEC.

The auditor confirmed the fund was a client, but was a bit cagey as to whether the audits had been clean or not. The audit partner described the operation as “rough around the edges.”

Not something you want to hear as a potential investor.

Every time you want to give someone pushing cryptocurrency the benefit of the doubt, remember this video

As it stands, LFIN has a market cap of about $6.5bn. Average trading volume is 4.5 million shares per day. For perspective, that is nearly twice the market capitalization of aerospace manufacturer Embraer, which does $6bn or so in revenue per year.

We have entered a new phase of cryptomania. This is the part where retail investors start bidding up the prices of anything even tangentially associated with cryptocurrencies, and fraudulent penny stock operators steal from them.

There is blood in the water. The sharks have sensed it. Now comes the feeding frenzy.

Please, please, please. If you are interested in this stuff, stop and think before you buy. Better yet, consult with a trusted financial advisor. Do not become an investing statistic.

No one is looking out for you. That may be painful to hear, but it is true. The SEC is always slow in catching these things and anyway you will never recover your losses even if the scammer is prosecuted. Many of your fellow crypto enthusiasts are incredibly naive about the pervasiveness of financial fraud, particularly in the world of microcap stocks. Do not give penny stock operators the benefit of the doubt.